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Category: Corporate Finance

17

Debating “The Shareholder Value Myth”

Many thanks to Larry and the Concurring Opinions folks for inviting me to blog this month. This is my first time blogging and I’m glad to finally try it out.

On Wednesday, I attended an event promoting Lynn Stout’s book The Shareholder Value Myth, sponsored by the Federalist Society and the American Enterprise Institute. The event was structured as a debate of Stout’s thesis with Jonathan Macey (who wrote this review of the book) taking the opposing position. In her book, Stout argued that the widely accepted norm that corporations are owned by shareholders and exist to maximize shareholder wealth is a destructive myth. Instead, Stout claimed, corporations own themselves and in running corporations, managers can and should pursue any lawful purpose.

It is a real credit to Lynn that there was such a lively, thought-provoking debate about the topic. That corporate managers have an obligation to work on behalf of shareholders to maximize shareholder wealth may be the most basic tenet of corporate law and policy. Options theory aside, many think of shareholders as the “owners” of the corporation and even those who question whether shareholders technically own the corporation do not doubt that the corporation should be operated in such a way as to maximize shareholder value. This unwritten “norm” has dominated corporate law, policy, scholarship, and, indeed, management for a long time (for precisely how long, Stout and Macey disagreed).  It is extremely impressive that Stout has been able to provoke a debate about the viability of this fundamental norm.

Wednesday’s debate was the second time I’d seen Stout present at a Federalist Society event. Both times, she began her presentation by arguing that hers was the truly conservative position. It seems an unlikely claim that surprises the audience given what her conclusions are, but I think it highlights what Stout does so well – she reaches her audience with their priors in mind in order to really draw them into her ideas where they might be tempted to dismiss her arguments out of hand. Her presentation was not about good corporate behavior or environmentalism, themes she touched upon in the book, but rather about how debunking the shareholder value myth would allow corporate law to favor state law over federal regulation, to prefer common law rules to statutory regulation, to enhance private ordering, and to honor the lessons of history.

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1

Today’s Stock Market Bubble: Mr. Market Is Alive and Still Unwell

The stock market rallies while recession continues to plague America. Chief executives worry, companies hoard cash, uncertainty haunts our banking system. Gas prices are up, GDP growth is down, unemployment is up, government debt and size are up and political leaders do not show the ability to come to grips with any of it.

Yet the Dow Jones Industrial Average, heading for 15,0000, exceeds levels not seen since October 2007, a few months before the current crisis showed up.  Believers in the efficiency of stock markets will take this as a sign of good times ahead, believing that markets reveal better than anything else the truth about business fundamentals.  Skeptics will plan to cite this as the first sign of a bubble.  Which view is the more plausible?

Believers in stock market efficiency buy the revolutionary ideas, hatched during the past 50 years, called modern finance theory.  This elaborate theory boils down to the notion that the best estimate of the value of a stock is its prevailing market price. The practical implication, of course, is that it is a waste of time to study individual investment opportunities in public securities. According to this view, you will do better by randomly selecting a group of stocks for a portfolio by throwing darts at the stock tables than by thinking about whether individual investment opportunities make sense.

Reverence for these ideas is not limited to ivory tower academics, but became standard dogma throughout financial America, from Wall Street to Main Street. Many professionals still believe that stock market prices always accurately reflect fundamental values, that the only risk that matters is the volatility of prices, and that the best way to manage that risk is to invest in a diversified group of stocks.

But a distinguished line of investors stretching back to Ben Graham and forward to Warren Buffett challenges such dogma by logic and experience.  Graham preached, and Buffett has successfully practiced, a different approach. Graham, who taught at Columbia Business School in the 1950s and ran an investment partnership, wrote a number of classic works, including The Intelligent Investor. There Graham argued that price is what you pay and value is what you get. These two things are rarely identical, but most people rarely notice any difference, he believed.

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1

Call for Papers: National Business Law Scholars Conference

I am delighted to pass along the following notice from the organizers of the National Business Law Scholars Conference.  I’m also honored to report that they have asked me to deliver the keynote at this year’s conference, and I look forward to doing so.  

Deadline Extended to May 31

We have received an enthusiastic response to the Call for Papers for the National Business Law Scholars Conference, scheduled for June 12-13, at The Ohio State University School of Law.  We will have additional openings for anyone who would like to make a presentation but has not yet responded.  Thus, we have extended the deadline to MAY 31st.  See the Call for Papers, re-posted below with the extended deadline date, for details on how to submit:

National Business Law Scholars Conference: Call-for-Papers

The National Business Law Scholars Conference (NBLSC)  will be held on Wednesday, June 12th and Thursday, June 13th at The Ohio State University Michael E. Moritz College of Law in Columbus, Ohio.  This is the fourth annual meeting of the NBLSC, a conference which annually draws together dozens of legal scholars from across the United States and around the world.  We welcome all on-topic submissions and will attempt to provide the opportunity for everyone to actively participate.  Junior scholars and those considering entering the legal academy are especially encouraged to participate.

To submit a presentation, email Professor Eric C. Chaffee at echaffee1@udayton.edu with an abstract or paper by MAY 31, 2013.  Please title the email “NBLSC Submission – {Name}”.  If you would like to attend, but not present, email Professor Chaffee with an email entitled “NBLSC Attendance”.  Please specify in your email whether you are willing to serve as a commentator or moderator.  A conference schedule will be circulated in late May.

Conference Organizers:

Barbara Black (University of Cincinnati)
Eric C. Chaffee (University of Dayton)
Steven M. Davidoff (The Ohio State University)

2

Theseus’s Paradox – Form and Substance in Evolving Capital Markets

Living in Beijing underscores the importance of change and adaptation.  There is a noticeable drop in the amount of processed sugar in foods, reflecting local (and healthier) tastes.  Virtually every restaurant delivers, including McDonald’s (which raises the ques­tion, if you’re going to order delivery, why McDonald’s?).  And, most parti­cularly, I recently joined the thousands of Chinese students and pensioners who weave in-and-around traffic on electric battery-powered mopeds.  It is a great way to get around the city (even if some of the pensioners have a tendency to cut you off).

The same focus on change arises in the capital markets.  A person who owns or sells a security is presumed to own or sell the financial risk of that security.  By selling shares, for example, the costs and bene­­­fits of those shares—the rise or fall in share price—are understood to run with the instru­­ments being sold.  Changes in the capital markets, how­­ever, have begun to call that pre­sump­tion into question.  Increasingly, market partici­pants can use new trading methods to sell instru­­­­­ments to one person, but transfer their financial risk to someone else.  The result is greater complexity and new chal­lenges to regulation and the regu­lators.

To what extent should the securities laws adjust to reflect those changes?  The answer largely turns on the question of “identity.”  Moving from modern-day Chinato to ancient Greece, the Greek historian Plutarch identified the question in his story of Theseus, the mythical king of Athens.  For many, Theseus is known for slaying the Mino­taur, a half-man, half-bull monster that devoured children sent to Cretein tribute to King Minos.  According to Plutarch, after Theseus returned to Greece, his boat remained in Athensharbor for centuries as a memo­­rial to his bravery.

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0

The Essays of Warren Buffett: Third Edition

It’s a pleasure to report that this weekend marks the release of the third edition of The Essays of Warren Buffett: Lessons for Corporate America.  Originally published as the centerpiece of a symposium sponsored by Cardozo Law Review in 1997 at which Warren Buffett debated 20-some law professors (listed after the jump) on every important issue facing corporate America, this book is a thematic arrangement of Buffett’s annual letters to the shareholders of Berkshire Hathaway from 1977 to the present.

As I explain in my Introduction,  the central theme uniting Buffett’s essays is that the principles of fundamental business analysis, first formulated by his teachers Ben Graham and David Dodd, should guide investment practice. Linked to that theme are management principles that define the proper role of corporate managers as the stewards of invested capital, and the proper role of shareholders as the suppliers and owners of capital. Radiating from these main themes are practical and sensible lessons on the entire range of important business issues, from accounting to mergers to valuation.

The book has particular significance for devotees of behavioral economics who are skeptical of strong claims about market efficiency, as the book provides both the philosophical architecture of value investing and the intellectual defense of that practice, which distinguishes sharply between price and value.
UPDATE:  Read More

0

The New York Fed and the Rule of Law

In Sunday’s New York Times, business columnist Gretchen Morgenson reported a piece of investigative journalism that is transcendently important, but whose complexity may have obscured that. It concerns secret dealings of the Federal Reserve Bank of New York. Morgenson explains the importance of her topic in terms of the threatened erosion of social trust that can occur when central banking officials engage in dubious behavior.

I would add that her topic, dubious dealings of central bankers, is of vital importance because those who run the FRBNY have enormous power in the field of banking regulation. They oversee the largest banks and provide direct input into the Financial Stability Oversight Council, the interagency government organization created by the Dodd Frank Act to oversee the financial system. It is empowered to intervene when the next financial crisis occurs, which could be later this year or five years or ten or what have you.

As with the financial crisis of 2008, these government actors, dominated by the FRBNY, will call all the shots about which institutions to save, sell or seize, on the one hand, and which creditors and shareholders to pay, wipe out or shortchange, on the other. How they exercise these powers is thus a matter of the utmost national interest. How they exercised them in the 2008 crisis remains both obscure and questionable. Read More

0

Word Clouds of Buffett’s Letters

Here are word clouds I created to visualize words Warren Buffett used most frequently in two of his famous letters to Berkshire Hathaway shareholders, the first based on his newest letter (2012, released Friday) and the second based on his oldest (1977).

The word “billion” has (inevitably) replaced the word “million;” Charlie (Munger) has assumed a preeminent position; acquisitions matter greatly now but not then; insurance float matters more in 2012 while insurance underwriting mattered more in 1977; BNSF and GEICO are big today, along with newspapers, not the textile company or trading stamp business as was true back then.  Quite a few other changes should be obvious as well.  Among the similarities: the centrality of earnings to discussions of corporate performance (particularly as compared to cash flow or dividends).

 

Buffett 2012 Letter Word Cloud

 

 

Buffett 1977 Letter Word Cloud

 

 

 

 

 

 

 



 

 

 

 

 

 

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Volume 60, Issue 3 (February 2013)

Volume 60, Issue 3 (February 2013)


Articles

Urban Bias, Rural Sexual Minorities, and the Courts Luke A. Boso 562
Private Equity and Executive Compensation Robert J. Jackson, Jr. 638
The New Investor Tom C.W. Lin 678


Comments

The Fate of the Collateral Source Rule After Healthcare Reform Ann S. Levin 736
A New Strategy for Neutralizing the Gay Panic Defense at Trial: Lessons From the Lawrence King Case David Alan Perkiss 778
3

Buffett + Heinz = Classic Application of Classic Lessons

Today’s report that Berkshire Hathaway, Warren Buffett’s company, along with 3G, will acquire Heinz, the venerable food products concern, reflects the acquisition criteria that Buffett has articulated for 20 years.  Essays explaining and outlining those criteria have appeared in my book, The Essays of Warren Buffett: Lessons for Corporate America, since its first publication in 1997.  Some excerpts follow (as they will appear on pages 211-214 of the forthcoming third edition):

 

We believe most deals do damage to the shareholders of the acquiring company. Too often, the words from HMS Pinafore apply: “Things are seldom what they seem, skim milk masquerades as cream.” Specifically, sellers and their representatives invariably present financial projections having more entertainment value than educational value. In the production of rosy scenarios, Wall Street can hold its own against Washington.

In any case, why potential buyers even look at projections prepared by sellers baffles me. We never give them a glance, but instead keep in mind the story of the man with an ailing horse. Visiting the vet, he said: “Can you help me? Sometimes my horse walks just fine and sometimes he limps.” The vet’s reply was pointed: “No problem—when he’s walking fine, sell him.” In the world of mergers and acquisitions, that horse would be peddled as Secretariat. 

At Berkshire, we have all the difficulties in perceiving the future that other acquisition-minded companies do. Like [them] also, we face the inherent problem that the seller of a business practically always knows far more about it than the buyer and also picks the time of sale—a time when the business is likely to be walking “just fine.” Read More

0

NBLSC Call-for-Papers

From our friends sponsoring the National Business Law Scholars Conference (NBLSC), scholars please take note of the following  Call-for-Papers:

The NBLSC will be held on Wednesday, June 12th and Thursday, June 13th at The Ohio State University Michael E. Moritz College of Law in Columbus, Ohio. This is the fourth annual meeting of the NBLSC, a conference which annually draws together dozens of legal scholars from across the United States and around the world.

All on-topic submissions are welcome and the sponsors will attempt to provide the opportunity for everyone to actively participate. Junior scholars and those considering entering the legal academy are especially encouraged to participate.

To submit a presentation, email Professor Eric C. Chaffee at echaffee1@udayton.edu with an abstract or paper by April 15, 2013. Please title the email “NBLSC Submission – {Name}”. If you would like to attend, but not present, email Professor Chaffee with an email entitled “NBLSC Attendance”. Please specify in your email whether you are willing to serve as a commentator or moderator. A conference schedule will be circulated in late May.

Conference Organizers: Barbara Black (University of Cincinnati); Eric C. Chaffee (University of Dayton); Steven M. Davidoff (The Ohio State University).